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Posted over 1 year ago

Hard Words From the Fed Chair - "Higher Rates For Longer"

After an impressive ramp in August, the financial markets puked all of it up on Friday after a brief message by the Federal Reserve Chairman, Jay Powell. What happened? And what does it mean? Up until Friday, the market has been giddy about the possibility of a "Fed pivot". The pivot crowd had convinced themselves that the Fed could not or would not be able to keep hiking interest rates past Q1 of 2023. CNBC and many of the financial minds on Wall Street were convinced that a stay or a pivot was in the making. The truth is, the markets have gotten so used to stimulus and cheap credit, that they cannot imagine a reality without it. "Surely Powell will stop hiking rates". "Surely he'll be lowering rates in early 2023" And the narratives go on and on. On Friday, from Jackson Hole, WY. Chair Powell forcefully declared that the Fed is on a mission to get inflation down and will keep rates higher for longer if that's what it takes. "It will be painful." He said. And it was certainly a painful day for the markets. The Dow fell 1108 points, 3.33% on Powell's short speech.

So where is this headed and what does it mean for real estate investors like us? Higher interest rates, let's face it, are going to be with us for longer than we had hoped. We need to deal with that. For those in fixed-rate mortgages against good rental properties, you actually are in a great position. Kudos to you if you were able to lock down low fixed-rate debt over the past few years. For sellers, this is not going to be the best time to sell. The buyers are facing higher loan-to-value requirements and higher debt payments. This is especially true in the residential market where values are tethered more to local median income and the buyer's ability to pay, which, let's face it, in a recession is contracting.  Commercial properties like multifamily, hotels, etc will not be as limited, but cap rate expansion and increased debt costs will force sellers to negotiate and settle for lower prices. The good news for real estate is that rent rates continue to increase. If you own houses, multifamily, storage, hotel interests, etc, your cash flow should expand as NOI expands. In this climate, I'm a holder and want to optimize my cash flow in line with the market. 

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Last year I was a seller, but over the next couple of years, I'm very happy to hold what I have as rent rates increase. On new acquisitions, buyers will need to be patient as it will take sellers some time before they stop looking in the rearview mirror at last year's prices. We had a commercial multifamily deal fall apart because the buyer's lender change the terms of the loan at the last minute. For the buyer of our 248-unit apartment community, it made the deal unworkable. The buyer had to forfeit $800,000 of earnest money and walk away. From our standpoint, we locked down a low fixed rate last year and have 5 years to run with it. We can hold for a long time, and rents are increaasing which means distributions to our investors are increasing. Not bad. We can wait to sell the property in a low-rate environment.

 The end of the real estate cycle is usually when the best deals occur. In the commercial space, there is less emotion involved and negotiations can be easier. Acquiring properties when interest rates are high can be incredibly lucrative. Eventually, the Fed will lower rates. I believe they are going to overtighten and break some things in the economy. I'm not sure how bad the markets will crash, but eventually, they will get inflation down around 3-5% and might feel the need the lower rates from there, especially if the economy suffers enough and hedge fund managers like Bill Ackman go on CNBC and cry a lot as he did in early 2020. Those who held their properties and were able to acquire new deals during a period of higher cap rates will then be holding valuable properties with compressing cap rates. That is the situation you want to find yourself in. That is how wealth is made in this debt-crazed economy. Rent rates are sticky, but as debt costs decrease, the NOI on those properties will create a ton of new value. 

Eventually, I think we're going to be dealing with higher long-term inflation. Higher than what we've been accustomed to. I doubt the Federal Reserve can get us back to a stable 2%. That ship has probably sailed. The upside of this is that for debtors, it could be a kind of debt jubilee as debt is deflated away in the midst of higher and higher rent rates. The economist Milton Friedman said that inflation is always and everywhere a monetary phenomenon. Sadly, it is one that will be with us for a while now. Real estate income is a hedge and a good spot to be in light of what's ahead. Onward. I do hear it's nice in Wyoming this time of year. But perhaps best to stay away from Jackson for a few days.




Comments (2)

  1. A.  Part of the Feds charge is to manage unemployment which luckily is near record lows.  So they can keep increasing interest rates for some time without affecting employment. They need higher unemployment to counter inflation.  Don’t see that happening in our area where they are having to much trouble finding employees.  Even if they do get laid off there are lower paying jobs they can take.  Thus see interest rates going up and staying up.    Don’t think higher unemployment will have the same impact on inflation as in prior periods.  
    B.  Commercial and industrial properties will have several issues to address or they will need to come to market or lower their sales price expectations.  1.  Owners aging out with no transition plan., 2.  4 year balloon or refi terms starting to come due., 3.  Keeping employees and the fun or lack of fun running a business.  


  2. A.  Part of the Feds charge is to manage unemployment which luckily is near record lows.  So they can keep increasing interest rates for some time without affecting employment. They need higher unemployment to counter inflation.  Don’t see that happening in our area where they are having to much trouble finding employees.  Even if they do get laid off there are lower paying jobs they can take.  Thus see interest rates going up and staying up.    Don’t think higher unemployment will have the same impact on inflation as in prior periods.  
    B.  Commercial and industrial properties will have several issues to address or they will need to come to market or lower their sales price expectations.  1.  Owners aging out with no transition plan., 2.  4 year balloon or refi terms starting to come due., 3.  Keeping employees and the fun or lack of fun running a business.